US stocks rally set to slow as investor ‘euphoria’ fades, say big banks

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Wall Street banks are betting that the blockbuster rally in US stocks will cool next year as investors turn cautious on technology companies’ ability to profit from their big investments in artificial intelligence.

Ten major banks, including Morgan Stanley, HSBC and Goldman Sachs, expect the S&P 500 index, the main US equities barometer, to rise roughly 8 per cent on average to around 6,550 between now and the end of next year, taking it to fresh highs.

That would be below the index’s historic average annual returns of around 11 per cent. So far this year the S&P has rocketed around 28 per cent on the back of big gains in technology stocks and Donald Trump’s presidential election victory, surprising many investors who had anticipated it would be held back by a slowing US economy.

“We’re fighting . . . euphoria that has helped people buy stocks versus the realities of next year,” said Mike Wilson, chief investment officer for Morgan Stanley.

US stock markets have been driven to record highs this year by gains for tech giants such as Nvidia, up 180 per cent, and Facebook parent Meta, which has gained around 73 per cent.

However, strategists expect that, having chased share prices higher for most of the year, investors will turn more cautious next year as Trump takes office.

US big tech is “entering a new phase”, said Venu Krishna, a strategist at Barclays, adding that there are “pockets of over-enthusiasm”, with technology giants yet to show they can monetise their AI investments.

“We are cautious because it is unrealistic for these kinds of exceptional returns to continue,” he said, adding “Big Tech are fully valued . . . US equities are fully valued.”

US equities now account for 70 per cent of the market value of global developed market stocks in MSCI’s widely followed World benchmark, compared with 30 per cent in the 1980s. The rise, which has been fuelled by years of strong gains, has propelled the price of US stocks to the highest level compared with global shares since records began more than a century ago. 

The six largest US tech companies, including Nvidia and Amazon, enjoyed average earnings growth of 33 per cent in the most recent quarter but analysts expect a rise of 16 per cent for 2025.

Morgan Stanley, Goldman Sachs and JPMorgan forecast the benchmark index to rise by around 7 per cent to the 6,500 mark.

However, Deutsche Bank has set a target of 7,000 for the benchmark by the end of next year, the highest among the 10 global banks. It said US equities looked exceptional because “the rest of the world is not growing,” while they on an absolute basis are “pretty normal” compared to the last decade.

Bankim Chadha, Deutsche Bank’s chief US equity strategist, forecast that an S&P rally would partly be driven by large share buybacks by companies. The bank expects buybacks rising to about $325bn a quarter next year, compared to the current rate of $275bn, to keep pace with corporate earnings.

“An increase in the buyback payout ratio could see them
rising even faster,” he said. “Valuations are unambiguously high but likely to sustain and maybe even go higher,” he added.

The forecasts come after a number of banks’ predictions for this year proved highly inaccurate, with stocks having risen past some analysts’ year-end forecasts before the end of 2023, and others having predicted a fall in the S&P in 2024.

Among the more bullish investment banks this time, Bank of America predicted the S&P would hit 6,666, as interest rates fall and investors adjust to a “massive recalibration” of the make-up of the benchmark.

Savita Subramanian, an equity and quant strategist at the bank, said many companies that had loaded up on debt and struggled with high rates had been relegated from the S&P. More profitable companies took their place. “A lot of rate risk and inflation risk has been managed out,” he said.

Analysts cautioned that there was still uncertainty around how inflationary Trump’s second term in office would be with potential tariffs on a host of countries including China and Mexico.

But banks expect tariffs to be countered by the president-elect’s pledge to cut corporation tax, with Goldman Sachs arguing that the two policies of the incoming president will “roughly offset one another”.

“We are in unfamiliar territory right now and everyone talks about uncertainty. But I think the uncertainty is bigger on the upside,” Deutsche’s Chadha added.